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Advantages of Marginal Costing

Marginal costing provides several advantages for cost control, short-term profit planning, and maximum return. It allows easier determination and control of production costs by avoiding arbitrary allocation of fixed overhead costs. It also helps assess comparative profitability through break-even charts and profit graphs. However, marginal costing has disadvantages including difficulty separately fixed and variable costs, potential for distorted profit pictures, and inability to be used for external reporting which require a complete view of costs. While useful for short-term decision making, marginal costing is less useful for long-term or situations where indirect costs impact decisions.

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585 views2 pages

Advantages of Marginal Costing

Marginal costing provides several advantages for cost control, short-term profit planning, and maximum return. It allows easier determination and control of production costs by avoiding arbitrary allocation of fixed overhead costs. It also helps assess comparative profitability through break-even charts and profit graphs. However, marginal costing has disadvantages including difficulty separately fixed and variable costs, potential for distorted profit pictures, and inability to be used for external reporting which require a complete view of costs. While useful for short-term decision making, marginal costing is less useful for long-term or situations where indirect costs impact decisions.

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devil
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© © All Rights Reserved
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Advantages of Marginal costing

Cost control: Marginal costing makes it easier to determine and control costs of production. By
avoiding the arbitrary allocation of fixed overhead costs, management can concentrate on
achieving and maintaining a uniform and consistent marginal cost.

Simplicity: Marginal costing is simple to understand and operate and it can be combined with
other forms of costing (e.g. budgetary costing and standard costing) without much difficulty.

Elimination of cost variance per unit: Since fixed overheads are not charged to the cost of
production in marginal costing, units have a standard cost.

Short-term profit planning: Marginal costing can help in short-term profit planning and is
easily demonstrated with break-even charts and profit graphs. Comparative profitability can be
easily assessed and brought to the notice of the management for decision-making.

Accurate overhead recovery rate: This method of costing eliminates large balances left in
overhead control accounts, which makes it easier to ascertain an accurate overhead recovery rate.

Maximum return to the business: With marginal costing, the effects of alternative sales or
production policies are more readily appreciated and assessed, ensuring that the decisions taken
will yield the maximum return to the business.

Disadvantages and Limitations of Marginal Costing


Classifying costs: It is very difficult to separate all costs into fixed and variable costs clearly,
since all costs are variable in the long run. Hence such classification sometimes may give
misleading results. Furthermore, in a firm with many different kinds of products, marginal
costing can prove less useful.

Accurately representing profits: Since the closing stock consists only of variable costs and
ignores fixed costs (which could be considerable), this gives a distorted picture of profits to
shareholders.

Semi-variable costs: Semi-variable costs are either excluded or incorrectly analyzed, leading to
distortions.

Recovery of overheads: With marginal costing, there is often the problem of under or over-
recovery of overheads, since variable costs are apportioned on an estimated basis and not on
actual value.

External reporting: Marginal costing cannot be used in external reports, which must have a
complete view of all indirect and overhead costs.
Increasing costs: Since it is based on historical data, marginal costing can give an inaccurate
picture in the presence of increasing costs or increasing production.

Conclusion: Marginal Costing Can Be Helpful for Short-


Term Decision Making
Marginal costing is a useful analysis tool which usually helps management make decisions and
understand the answer to specific questions about revenue.

That said, it is not a costing methodology for creating financial statements. In fact, accounting
standards explicitly exclude marginal costing from financial statement reporting. Therefore, it
does not fill the role of a standard costing, job costing, or process costing system, all of which
contribute actual changes in the accounting records.

Still, it can be used to discover relevant information from a variety of sources and aggregate it to
help management with a number of tactical decisions. It is most useful in the short term, and
least useful in the long term, especially where a firm needs to generate sufficient profit to pay for
a large amount of overhead.

Furthermore, direct costing can also cause problems in situations where incremental costs may
change significantly, or where indirect costs have a bearing on the decision.

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